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ADMS 2500 Module 9- Accounting for Inventories.docx

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Administrative Studies
Course Code
ADMS 2500
Brian Gaber

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ADMS 2500 Nov.04.2011 Module 9- Accounting for Inventories Inventory - goods held by retail or wholesale business called merchandise inventory - goods held for sale by manufacturing called finished inventory - inventories of manufacturing also include raw materials and work in progress inventory - significant asset - inventory accounting for merchandisers is the firm that buys the finished products to sell to their customers The Need for Inventories - need to decide optimal level of inventory to carry - firm can sell more goods then it purchases or produces only if it has a beginning inventory Inventory Valuation - accounting correctly for inventories is important in determining net income - changing dollar amount for ending inventories changes net income dollar for dollar - dollar amount of inventory dependent on: ~ quantity ~ price quantity x price = goods on hand at specific time - ‘taking’ inventory means: (1) counting the items involved (2) pricing each item (3) summing the amounts Effect of Inventory Errors - accounting inventories effects income measurement by assigning costs to different accounting periods as expenses - total cost of goods for sale during the period must be allocated between current period’s usage (COGS, an expense) and amounts carried forward (end of period inventory, an asset) - overstating/understating inventory overstates/understates income Complexities of Inventory Accounting - major problems in inventory accounting arise because the unit acquisition costs of inventory items fluctuate over time - variation in values of inventories result only from the changes of quantities Specific Identification and the Need for a Cost Flow Assumption - individual items sold can sometimes be matched with specific purchases - cost can be marked on the unit or on its customer, or the unit can be traced back to its purchase invoice or receipt - accounting solves issue of tracing cost flow not physical flow of goods - inventory costing problem arises because of two unknowns in the inventory equation: - question is to compute amounts for the units in ending inventory based on: most recent costs, oldest costs, average costs or some other cost Cost Flow Assumptions - accountant computes acquisition cost applicable to the units remaining in the inventory - three cost flow assumptions: (1) first-in, first-out (FIFO): oldest costs are flowed to cost of goods sold, most recent costs are used to value inventory (2) last-in, first-out (LIFO): most recent costs are flowed to cost of goods sold, oldest costs used to value inventory (3) weighted average: both units sold and units remaining in inventory are priced at the weighted average- dollar value of goods available for sale/unit available for sale First-in, First-out (FIFO) - assigns cost of earliest units acquired to the withdrawals and the cost of the most recent acquisitions to the ending inventory - the cost flow assumes that the oldest materials and goods are used first - cost flow assumption conforms to good business practice in managing physical flows, especially in the items that deteriorate and become obsolete Ex: TV set 1 is assumed to be old; whereas TV sets 2 and 3 are assumed to remain in inventory Weighted Average - average costs of all goods available for sale during the accounting period including the cost applicable to beginning inventory must be calculated - applied to units sold and those on hand at the total dollar amount at the end of the month Ex: if TV set sold on the last day of the accounting period than 280 [=t/3 x (250 + 290 + 300)] cost of goods sold is $280 and ending inventory is $560 = 2 x 280 - only works in a periodic inventory system - if perpetual system is used, must use moving average, where units are recognized as coming and going and must redo the calculations after every transaction Last-in, First-out (LIFO) - assigns cost of latest units acquired to the withdrawals and the cost of the oldest units to the ending inventory Ex: if TV set sold on last accounting period when all three sets
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